CMA_P1_SectionA_FC Flashcards
CMA Part 1 Section A
Who are direct users of financial statements?
Direct users are directly affected by a company’s financial results and stand to lose money if the company has financial problems.
Direct users include investors and potential investors, employees, management, suppliers, and creditors.
Who are indirect users of financial statements?
Indirect users are people or groups who represent direct users.
Indirect users include financial analysts and advisors, stock markets, and regulatory bodies.
What are the five financial statements?
- Balance sheet (also called the statement of financial position)
- Income statement
- Statement of cash flows
- Statement of comprehensive income
- Statement of changes in stockholders’ equity
What does the balance sheet show?
The balance sheet provides information about an entity’s assets, liabilities, and owners’ equity at a point in time.
What are the elements ofthe balance sheet?
- Assets
- Liabilities
- Equity (or net assets)
What is the proprietary theory?
Proprietary theory is the way that the balance sheet presents the assets, liabilities, and equity, showing that the net assets belong to the owners of the company.
What is an asset?
Future economic benefits obtained or controlled by an entity as a result of past transactions or events.
What is a liability?
Probable future economic sacrifices of economic benefits that arise from the present obligations of the company to transfer assets or provide services to other entities in the future as a result of past transactions or events.
What is equity?
The remaining balance of assets after the subtraction of all liabilities. This is the amount of the company’s assets that are owned by and owed to the owners.
What are current assets?
Assets that will be converted into cash or sold or consumed within 12 months or within one operating cycle if the operating cycle is longer than 12 months.
What are current liabilities?
Obligations that will be settled through the use of current assets or by the creation of other current liabilities.
What are the six categories of equity?
- Capital stock
- Additional paid-in capital
- Retained earnings
- Accumulated other comprehensive income items
- Treasury stock
- Non-controlling interest
What does the balance sheet help assess?
The balance sheet provides a basis for computing rates of return, evaluating the capital structure of the business, and predicting a company’s future cash flows.
The balance sheet helps to assess the company’s liquidity, financial flexibility, solvency, and risk.
What are some of the limitations of the balance sheet?
- Many assets are not reported on the balance sheet.
- Values of certain assets are measured at historical cost.
- Judgments and estimates determine the value of many items reported in the balance sheet.
- Most liabilities are valued at the present value of cash flows discounted at the rate that was current when the liability was incurred, not at the present value of cash flows discounted at the current market interest rate.
What does the income statement show?
The results of a company’s operations during a given period of time.
What does the income statement help assess?
The amounts, timing, and uncertainty of (or prospects for) future cash flows.
What are the four elements of the income statement?
- Revenues
- Expenses
- Gains
- Losses
What are revenues?
Revenues represent inflows of assets or reductions in liabilities as a result of delivering goods or providing services that are the entity’s main or central operations.
What are expenses?
Expenses are outflows of cash or other assets or the incurrence of liabilities as a result of purchasing goods or services that are necessary to provide the entity’s main or central operations.
What are the three methods of recognizing expenses?
- Cause and effect
- Systematic and rational allocation
- Immediate recognition
What is matching?
Revenues should be recognized in the same period as the expenses that generated those revenues are expensed.
What are gains?
Increases in equity as a result of transactions that are not part of the company’s main or central operations and that do not result from revenues or investments by the owners of the entity.
What are losses?
Decreases in equity as a result of transactions that are not part of the company’s main or central operations and that do not result from expenses or distributions made to owners of the entity.
What is a discontinued operation?
A disposal of a component or group of components that is either disposed of or held for sale and represents a strategic shift that has or will have a major effect on the entity’s operations and financial results
What is the primary purpose of the statement of cash flows?
The primary purpose of the statement of cash flows is to provide information regarding receipts and uses of cash for the company during a specified period of time
What are the threecategories of activities onthe statement of cash flows?
- Operating activities
- Investing activities
- Financing activities
What are the two methods of preparing the statement of cash flows?
- Direct method
2. Indirect method
Under the indirect method, what account is adjusted to calculate cash flows from operations?
Net income is adjusted under the indirect method.
What are thefive categories of adjustments under the indirect method?
- Eliminate noncash income and expense items.
- Eliminate investing and financing activity events whose results are included in the income statement.
- Include the effect of any operating activities that were not included in net income but did have a cash effect and exclude (eliminate) the effect of any events that are included in net income but did not have a cash effect.
- Adjust cash flows from the purchase, sale, and maturity of trading securities.
- Specific disclosures required with the indirect method.
What is the adjustment to net income for an increase in the net receivable position during the year?
The amount of the increase in net accounts receivable is subtracted from net income because the cash corresponding to this amount of revenue recognized during the period was not received during the period.
A decrease in receivables during the period is added to income.
What is the adjustment to net income for the change in an asset during the period?
- The amount of an increase in an asset account should be deducted from net income.
- The amount of a decrease in an asset account should be added to net income.
What is the adjustment to net income for the change in a liability during the period?
- The amount of an increase in a liability account should be added to net income.
- The amount of a decrease in a liability account should be deducted from net income.
How are noncash investing and financing activities reported on the statement of cash flows?
Separately in a schedule at the end of the statement of cash flows.
What is included in the statement of comprehensive income?
Comprehensive income includes all transactions of the company except for those transactions that are made with the owners of the company (such as distribution of dividends or the sale of shares).
What is shown in an integrated report?
An integrated report incorporates non-financial information along with the financial information provided in financial reports and shows how the financial information is influenced by the non-financial information over the short, medium, and long term.
What are the six capitals in the IR (Integrated Reporting) Framework?
- Financial capital
- Manufactured physical capital
- Intellectual capital
- Human capital
- Social and relationship capital
- Natural capital
What is the primary purpose of integrated reporting?
To explain to providers of financial capital how an organization creates value over time.
What are the guiding principles for preparing and presenting an integrated report?
- Strategic focus and future orientation
- Connectivity of information
- Stakeholder relationships
- Materiality
- Conciseness
- Reliability and completeness
- Consistency and comparability
What items are included in cash?
- Cash (of any currency)
- Savings accounts
- Checking accounts
What are cash equivalents?
Cash equivalents are defined as very short-term, highly liquid investments that are (1) readily convertible to a known amount of cash, and (2) so near their maturity that there is no significant risk of changes in value because of a change in interest rates.
Usually, only securities with original maturities of three months or less when acquired by the company qualify to be classified as cash equivalents.
What are the two allowed methods for valuing accounts receivable?
- Percentage of sales method
2. Percentage of receivables method
What is calculated and what is a residual balance under the percentage of sales method?
The amount of credit loss expense is calculated and the ending balance in the allowance account is the residual amount.
What is calculated and what is a residual balance under the percentage of receivables method?
The ending balance in the allowance account is calculated and the amount of credit loss expense is the residual amount.
What are the two ways that receivables may be factored?
- Without recourse
- With recourse – in this case the seller of the receivables must report a recourse liability on its balance sheet for the estimated amount of any uncollectible receivables
What value should inventory be recorded at when it is purchased?
Inventory should be recorded in the books at the amount that includes all of the costs paid for getting the inventory ready and available for sale.
Costs include the cost of the inventory, shipping costs to receive the inventory, insurance, taxes and tariffs, duties, and all other costs related to receiving the inventory to sell to the customer.
Are in-transit goods included in inventory?
The owner of the goods at year-end is determined by the terms of shipping.
- Goods sent FOB Shipping Point belong to the buyer from the moment the seller gives them to the shipping company.
- Goods sent FOB Destination belong to the seller until the buyer receives them.
When are consigned goods included in inventory?
Consigned goods are included in the inventory of the company that has the goods out on consignment.
Ownership of the consigned goods transfers directly from the producer of the goods to the final purchaser.
What are the cost flow assumptions for inventory?
- First in First Out (FIFO)
2,. Last in First Out (LIFO) - Average Cost
- Specific Identification
Which inventory method is not permitted under IFRS?
LIFO is prohibited under IFRS.
When prices are rising, which inventory method has the highest balance of ending inventory?
FIFO
When prices are rising, which inventory method has the highest COGS?
LIFO
When prices are rising, what inventory method has the highest gross profit?
FIFO
To prevent the overstatement of inventory, how should inventory be valued on the balance sheet?
Inventory using LIFO or the retail method is valued at the lower of cost or market.
All other inventory is valued at the lower of cost or net realizable value.
How is the net realizable value calculated?
Selling price
− Cost to complete and dispose
= Net realizable value
Under lower of cost or market, what are the three values used to determine the market value?
The middle of these three amounts is used as the market value:
- The ceiling, which is the net realizable value (NRV)
- Replacement cost
- The floor, which is the NRV minus a normal profit margin
What are the six methods used to account for investments?
- Amortized cost
- Fair value through other comprehensive income
- Fair value through income statement
- Cost less impairment
- Equity method
- Consolidation
What are the three classifications of debt investments and how are they accounted for?
- Trading – fair value through the income statement
- Held-to-maturity – Amortized cost
- Available-for-sale – fair value through other comprehensive income
How are equity investments accounted for when
the investor does NOT have significant influence?
- Fair value through the income statement when the shares have a readily determinable fair value.
- Cost less impairment when the shares do not have a readily determinable fair value.
Not having influence is usually shown when the investor owns 20% or less of the shares of the investee.
How are equity investments accounted for when
the investor DOES have significant influence?
The equity method is used when the investor has significant influence over the investee.
Significant influence usually occurs when the investor owns 21-50% of the shares of the investee.
What are the main adjustments in the consolidation process?
- Eliminating intercompany receivables and payables
- Eliminating the effect of intercompany sales of inventory
- Eliminating the effect of intercompany sales of fixed assets
- Eliminating the parent’s investment account
Fixed assets are recorded using what cost?
Fixed assets are recorded at historical cost, which is the amount paid for the asset and all other costs that are necessary to get the asset ready for use.
What is depreciation?
Depreciation is the systematic and rational allocation of the costs of a fixed asset over its expected useful life.
This is the process by which the expense of the asset is matched with the revenue it generates.
What are the methods of depreciation?
- Straight-line
- Double declining balance
- Sum-of-the-years’-digits
- Units of production
When are intangible assets amortized?
Whether an intangible asset is amortized or not depends on its useful life:
- If the asset has a determinable, limited life, it is amortized over that useful life.
- If the asset does not have a determinable useful life, the asset is not amortized, but it must be tested regularly for impairment.
What is goodwill and how is it reported on the balance sheet?
Goodwill is the amount that a purchaser has paid for a company that is greater than the fair value of the net identifiable assets.
Purchased goodwill must be reported as a separate line item on the balance sheet.
What are the two types of warranties?
- An assurance-type warranty is a manufacturer’s warranty given along with the sale of the product that provides assurance only that the product meets agreed-upon specifications in the contract at the time it is sold, without any additional payment being required from the customer.
- A service-type warranty is an extended warranty that is usually sold separately from the product.
What is book income and what is taxable income?
Book income is the company’s income as calculated according to US GAAP.
Taxable income is the income on which the company must pay taxes as calculated according to the tax code.
How do temporary timing differences arise?
Temporary timing differences arise when an item is not recognized for both book and taxable income in the same period.
What is a deferred tax asset and how does it arise?
A deferred tax asset is in essence an “overpayment” of taxes when taxable income is higher than book income.
A deferred tax asset is created by either of the following:
- An item that is taxable revenue in the current period but is not included in book revenue.
- An expense that is reported on the income statement for the current period but is not deductible for tax purposes.
What is a deferred tax liability and how does it arise?
A deferred tax liability is in essence an “underpayment” of taxes because taxable income is lower than book income.
A deferred tax liability is created by either of the following:
- An item is included in revenue for book purposes but not included in revenue for tax purposes.
- An expense that is deductible for tax purposes but is not an expense for book purposes.
How is the deferred income tax or expense calculated?
It is calculated as the amount of change in the total deferred tax asset and liability position of the company during the period.
How are deferred tax assets and liabilities presented on the balance sheet?
All deferred tax assets and liabilities and any related valuations are classified as noncurrent on the balance sheet.
The company will net together the deferred tax assets and the deferred tax liabilities to determine the net deferred tax position to be shown as a noncurrent item on the balance sheet.
What are permanent timing differences?
Permanent timing differences are items that cause differences between taxable income and book income that do not reverse over time.
Permanent differences do not give rise to deferred tax assets or liabilities because a permanent timing difference will be recognized for either book or tax purposes, not both.
How are net operating losses treated?
80% of net operating losses may be carried forward indefinitely and used to offset future taxable income.
What is a lease?
A lease is an agreement between a lessor (the owner of an asset) and a lessee (the entity that is going to use the asset) that conveys the right to use specific property for a stated period of time in exchange for a stated payment.
What are the two classifications of leases?
- Operating leases – a rental agreement
2. Finance leases – a purchase/sale agreement
What are the types of dividends that a company can pay?
- Cash dividend
- Liquidating dividend
- Property dividend
- Stock dividend
How is a stock dividend valued?
A small stock dividend (usually less than 20-25%) is valued at the fair value of the shares.
A large stock dividend (usually more than 20-25%) is valued at the par value of the shares.
A small/large stock dividend distinction is based on whether or not the issuance will impact the price of the stock.
What is treasury stock?
Treasury stock is shares of a company that have been sold to other parties and then reacquired by the company.
What are the three classifications of shares on the balance sheet?
- Authorized shares
- Issued shares
- Outstanding shares
When is revenue recognized?
There are five steps to the revenue recognition process:
- Identify the contract with a customer.
- Identify the separate performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the separate performance obligations.
- Recognize revenue when or as each performance obligation is satisfied.
What are the two methods of accounting for long-term contracts?
- Point-in-time recognition
2. Over-time recognition
What are the three steps of the over-time method?
- Calculate the amount of the total estimated gross profit on the project.
- Determine what percentage the project is completed, usually based on costs incurred to date.
- Determine how much of the profit should be recognized in the current period.
How is the estimated gross profit calculated for a long-term contract?
Contract price
− Costs actually incurred to date
− Estimated costs to be incurred in the future
= Expected gross profit (loss) on the project
How is thepercent complete calculated?
Total Costs Incurred to Date (including prior periods)
/
Costs Incurred to Date + Estimated Cost to Complete
How is the profit to be recognized under the completed contract method calculated?
Expected Profit
× Percentage Complete
= Total Profit to Be Recognized to Date
– Profit Previously Recognized
= Profit to Recognize This Period
How are expected losses recognized in long-term contracts?
Under both methods, losses are recognized in full as soon as there is an expected loss on a contract.
